It looks like the BOJ is finally going to go through with a rate hike at Friday’s meeting. The last time Japan’s central bank raised rates was in January, and inflation has remained well above target. Officials have sought to curb consumer price inflation by threatening higher rates, and the market now believes they will deliver.

Naturally, the asset expected to be most affected is the yen and its pairs. But the BOJ’s decision could have implications for other assets, given its global significance. Gold and other precious metals could be particularly affected, as investors seek safe havens amid high government debt. Investors are charging higher premiums on government bonds amid concerns about default risk and rising inflation, which generally benefits safe-haven assets like gold. The BOJ’s interest rate hikes are seen as undermining the yen’s safe-haven status, prompting traders to seek alternatives.
 

What Are Markets Expecting from the BOJ Meeting?

Economists are practically unanimous, and the market is pricing in a 100% chance of a BOJ rate cut on Friday. This means the immediate reaction to the rate decision may be muted if it meets expectations. The focus will then turn to what happens next, which can be complex and increase the risk of market volatility.

The BOJ faces a complex problem. A weak yen and sticky inflation would naturally mean the central bank would raise rates. But, if it does, then lending rates in Japan would rise to a 30-year high. This would increase the cost of servicing debt, which for Japan’s government is enormous. The country’s debt-to-GDP ratio is 240%, and higher rates would put increasing strain on the government’s finances. New Prime Minister Sanae Takaichi has promised to increase spending, implying higher borrowing at ever-higher interest rates. This puts the BOJ’s policy and the government’s spending priorities on a collision course.
 

What Happens After the Hike?

The issue is that if the BOJ raises rates too quickly, it could disrupt the Japanese debt market. Banks and other financial institutions holding government bonds would face significant losses if interest rates (JGB yields) rose substantially. That could trigger a financial crisis. Carry trades capitalize on lower interest rates in Japan and set an interest-rate floor for global finance. That means the potential financial crisis could spread internationally.

To prevent this, the BOJ would have to avoid raising rates too quickly. Meaning that if the BOJ does go through with a rate cut on Friday, it will be unlikely to hike again for several months. Essentially, it will “exhaust its ammunition”. With the BOJ unable to raise rates, market forces could take over, weakening the yen to capitalize on current interest rates. This would create a paradoxical reaction: interest rate hikes typically lead to a stronger currency.
 

What to Look Out For

The BOJ will likely seek to avoid this adverse scenario by maintaining its hawkish tone. That would include a strong emphasis on inflation and on upcoming wage negotiations, which will conclude in March. If the BOJ convinces the market that it will proceed with another hike in April, the yen could gain further strength after the meeting.

The rate decision could also affect gold, as it is the last major economic event of the year. Major traders are likely to start their holidays soon after the meeting, and will want to secure their positions through the long holiday period. That means the price of gold and other precious metals could remain supported.

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